As i was waiting for my car to be serviced, an article on The Edge showed stocks that are buying back their own shares. Here the top 10 stocks that bought shares back this quarter:
Now, I have been asked a number of times, as a value investor, what do I think about shares buy back. Well, the easiest way to think about it is to imagine yourself owning a business with some partners.
Why Shares Buy Back Is Good!
Let's say you have a car servicing business which you co-own with another 4 friends. Altogether, there are 5 equal shareholders.
If your business is making $100,000 per year, each shareholder gets $20,000 of profits.
Take $100,000 divided by 5 shares = $20,000
Now, what if the business buys back one of the shares. There will be 4 shares remaining and if the business continues to make $100,000, now each shareholder makes $25,000
Take $100,000 divided by 4 shares = $25,000
Without doing much or improving the business, each shareholder now makes more.
So generally speaking, when a company buys back shares, it benefits the existing shareholders.
Shares Buy Back must be Done at a Good Price
Now, that's not all to it. An important aspect is to buy the shares back at a good price. Imagine buying back the shares of the car servicing business at 2 million dollars! That will be ridiculous since each share is only earning $20,000.
So a reasonable price to pay for a share of a non listed business is probably 3 to 5 times of how much it can make (there are other methods to valuate of course, but we will leave it in next postings), so it is probably worth around $60,000 to $100,000.
Now what if one of the shareholders need money urgently or feel pessimistic about the business and is willing to sell the shares back to the business at $50,000?
It will be beneficial for the existing shareholders to increase your profits per share at a cheaper price.
This is what these companies like DBS did recently as the share prices fall.
So in my opinion, I am glad that the companies are buying back their shares when prices fall recently so as a shareholder, even if you do not have cash to invest in these times, your company is actuallly doing that for you.
Shares Buy Back is not the Main Criteria
Of course, shares buy back is not the main criteria, they must be good and profitable before we should even consider investing, shares buy back is an added bonus and an indication that company is increasing shareholder's value when done at a relatively cheap price.
Cheers to your Value Investing and Financial Freedom!
Team VIC, Founder
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